Europe manager Neil Wilkinson is set to largely avoid the continent’s small-cap companies until after their expected negative reaction to a US rate rise.
The manager took on Royal London Asset Management’s European Opportunities fund in July last year when the group changed it from the previous income-focused mandate.
At the time, Mr Wilkinson said he wanted to focus on small- and mid-cap names, but in spite of his wide-ranging overhaul of the fund, he owns only three such stocks.
The manager has substantially trimmed the number of holdings from 55 to 40 by selling down about 20 holdings and bringing in a handful more.
But the changes have not included a large skew towards smaller companies, something the manager indicated would happen with the fund under his stewardship.
“Small and mid caps are not where I would expect them to be through the cycle,” he said.
“I am a bit nervous about the sector, going into a Federal Reserve rate rise.”
When the US Federal Reserve does decide to raise rates – now expected some time this year or next – small caps are likely to underperform, the manager claimed.
“Small caps offer great opportunities over an investment cycle but there are periods when you would expect them to underperform, most likely when liquidity is withdrawn such as through rate rises or tapering,” Mr Wilkinson said.
The manager said he would probably use a small cap sell-off as an opportunity to snap up several small- and mid-cap names on weakness.
While Mr Wilkinson waits for a chance to increase his exposure to small and mid caps, he has been drawn towards larger companies.
But he said it had become “much harder to find genuine cheap value in the current environment, given the market has had a good run”.
One of the “gems” the manager said he had unearthed in Europe was Bayer, the German-based multinational pharmaceutical company. It is his fifth largest holding, making up 3.2 per cent of his portfolio.
The company has had a strong year so far, benefiting from the weaker euro.
At the end of April it announced its pre-tax earnings would grow by the “high-teens” compared with its earlier prediction of a low- to mid-teen gain.
The £280.6m RLAM fund has performed strongly so far this year. It has returned 12.4 per cent in 2015 to May 6, compared with its benchmark, the FTSE World European ex UK index, which has returned 11.5 per cent and the sector, the IA Europe excluding UK sector, which has returned 11.3 per cent, according to data from FE Analytics.
Mr Wilkinson’s says the outperformance is the result of being overweight in two banks – ING and KBC. At the end of February, he held a 3.7 per cent overweight in ING and a 2.6 per cent overweight to KBC. Both these stocks have done well so far this year.
While he likes these banks, he remains underweight banks in peripheral Europe as he is “concerned about the capital position” and thinks they are “relatively fully valued businesses that do not have much growth potential”.